Every investor has an asset allocation. Some people just let
theirs happen, others choose theirs. The best allocations are those
that are chosen wisely and designed to fit specific investment
needs. Here's what you need to know to start thinking about
Asset allocation starts with the universe of investments. That
universe is made up of different types, called asset classes. Some
asset classes give you the potential for strong returns but also
carry the possibility of significant volatility. Others may be very
consistent in value but produce relatively little return. Any
combination of asset classes can serve as ingredients in investment
Asset allocation is the art and science of choosing these
ingredients. Your allocation will define which investments you
choose to emphasize, and how much of each you plan to use. Research
suggests that this decision may be the most fateful choice you can
make in building a portfolio to meet your needs.1
The Main Asset Classes: Stocks, Bonds, and
Here's a closer look at each:
- Stocks -- Well known for fluctuating
frequently in value, stocks carry a high level of market risk (the
risk that your investments' value could decrease). However, stocks
have historically earned higher returns than other asset classes by
a wide margin, although past performance is no predictor of future
results. Stocks have also outpaced inflation -- the rising prices
of goods and services -- at the highest rate through the years and
therefore carry very low inflation risk.
- Bonds -- In general, these securities have
less-severe short-term price fluctuations than stocks and therefore
offer lower market risk. On the other hand, their overall inflation
risk tends to be higher than that of stocks, as their long-term
return potential is also lower. Bond returns may also be influenced
by changes in interest rates. Rising rates are associated with
falling prices, and vice versa.
- Money market
instruments2 -- Among the
most stable of all asset classes in terms of returns, money market
instruments carry very low market risk. At the same time, these
securities don't have the potential to outpace inflation by as wide
a margin through the years as stocks.
How They Performed
investments offer different levels of potential return and market
risk. Unlike stocks and corporate bonds, government T-bills are
backed by the full faith and credit of the United States, although
money market funds that invest in them are not. Past performance is
not indicative of future results.
Source: ChartSource®, DST Systems, Inc. For the
period from January 1, 1989, through December 31, 2018. Large-cap
stocks are represented by the S&P 500 index. Midcap stocks are
represented by a composite of the CRSP 3d-5th deciles and the
S&P 400 index. Small-cap stocks are represented by a composite
of the CRSP 6th-10th deciles and the S&P 600 index. Bonds are
represented by the Bloomberg Barclays U.S. Aggregate Bond index.
Cash is represented by a composite of the yields of 3-month
Treasury bills, published by the Federal Reserve, and the Bloomberg
Barclays U.S. Treasury Bill 1-3 Month index. Foreign stocks are
represented by the MSCI EAFE index. The "60/30/10" portfolio is
composed of 60% stocks (S&P 500 index), 30% bonds (Bloomberg
Barclays U.S. Aggregate Bond index), and 10% cash (a composite of
yield on 3-Month Treasury Bills and the Bloomberg Barclays U.S.
Treasury Bill 1-3 Month index). It is not possible to invest
directly in an index. Index performance does not reflect the
effects of investing costs and taxes. Actual results would vary
from benchmarks and would likely have been lower. Past performance
is not a guarantee of future results. © 2019, DST Systems,
Inc. Reproduction in whole or in part prohibited, except by
permission. All rights reserved. Not responsible for any errors or
From a Bunch to a Pattern
The process of creating an asset allocation begins with a goal
and a time frame for reaching that goal. Goals that are further in
the future allow you to take larger risks in pursuit of greater
rewards. Goals that are more immediate require you to give greater
emphasis to assets that can help you preserve what you have. In
practical terms, that suggests:
A young person saving for eventual retirement might have a
larger proportion of stocks and relatively smaller portions of
bonds and money market instruments;
Retirement savers in the middle of their careers might want to
shift some portfolio emphasis to bonds from stocks; and
Those nearing retirement might want less in stocks and bonds,
and more in money markets or their equivalents.
Asset allocation does not ensure against risk of loss. What's
more, portfolio allocation plans can be very personal, so
individual portfolio recipes can differ. Among the other factors to
consider are your investment judgements and your comfort with risk.
But regardless of the asset allocation strategy you choose and the
investments you select, keep in mind that a well-crafted plan of
action over the long term can help you weather all sorts of
changing market conditions as you aim to meet your investment
Asset allocation and diversification do not ensure a profit or protect against loss.
1A landmark study shows that about 90% of the variability of returns earned by balanced mutual funds and pension plans over time was the result of variation in asset allocation policy. Source: Financial Analysts Journal, "Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?," January/February 2000.
2An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other federal government entity. Although the fund may seek to preserve the value of your investment at $1.00 per share, there can be no guarantee that the fund will maintain it. It is possible to lose money by investing in a money market fund. A fund's yield will vary.